Do Nonprofessional Investors React to Fraud Red Flags?
Joseph F. Brazel
North Carolina State University - Poole College of Management - Department of Accounting
University of Georgia - C. Herman and Mary Virginia Terry College of Business
Keith L. Jones
George Mason University
Jane M. Thayer
University of Georgia - J.M. Tull School of Accounting
April 16, 2012
Investor losses from fraud have become a significant concern for policymakers. We experimentally examine whether experienced, nonprofessional investors react to fraud red flags. Prior research has shown that fraud firms exhibit multiple red flags in their 10-Ks prior to the detection of fraud. However, these red flags are not typically transparent to investors in the current financial reporting environment. We find that a transparent presentation of differences in key financial measures and nonfinancial measures (NFMs) that indicates multiple red flags leads to lower investment positions than a presentation of these red flags that is not transparent. This finding is important as it suggests that when multiple fraud red flags are present but not transparent, investors continue to invest in firms where losses from fraud are more likely. Additionally, we find that when only a single red flag is present (i.e., lower fraud risk), a transparent presentation does not affect investment levels.
Number of Pages in PDF File: 49
Keywords: accruals, fraud, investor, nonfinancial measures, red flag
JEL Classification: M40, M41working papers series
Date posted: January 12, 2010 ; Last revised: April 18, 2012
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